India’s money

India was recognised and received the comity of nations when it signed the Treaty of Versailles as a victor, later becoming a Dominion and successor-state of British India in 1947, and a sovereign republic in 1950. Pakistan emerged as a new state created out of British India in 1947, remaining a Dominion until 1956 when it became an Islamic republic.

India was an original member of the League of Nations, a signatory to the UN’s San Francisco Declaration, a participant at Bretton Woods, and an original member of the IMF.

Yet some 65 years later, sovereign India has failed to develop a currency universally acceptable as a freely convertible world money. Nor do trade, monetary, fiscal or political conditions appear such that the rupee can become a hard currency of the world economy easily or very soon.

JM Keynes in his first book, a century ago, gave a masterly survey of the immediate monetary history. The rupee had been on a silver standard until 1893 when an attempt at bimetallism failed; instead India stumbled into the 20th century on a modified gold standard that chanced to fulfil desiderata known since Ricardo, namely “the currency media used in the internal circulation are confined to notes and cheap token coins, which are made to act precisely as if they were bits of gold by being made convertible into gold for foreign payment purposes”.

Ie, the rupee was legal tender at home and convertible into sterling for international payments in London, the price being set at 1s 4d. Gold at £3.17s.10½d until August 1914 meant a rupee price of Rs 31 per troy oz.- long-forgotten now when gold retails at Rs 90,000 per troy oz, measuring an average annual rate of inflation in the gold price of about 8.5 per cent for the century.

Until 1947 the rupee remained subservient to British policy. Sterling payments included paying for merchandise imports, dividends and repayments on British business, as well as iniquitous “home charges” imposed by Britain to rule India as an unfree imperial dependency. Britain “returned to gold” in 1925, and did so notoriously at the same price as before though the rupee was revalued to 1s 6d.; Indian businessmen complained to no avail that this hurt exports and worsened the large deflation caused by the Depression. The same continued after sterling became a paper money again in September 1931, backed only by London’s position as a financial capital.

India remained a major trading nation during 1870-1914 with a share of world manufactured exports as high as 4 per cent. Keynes found Britain (the world’s largest exporter), exporting most to India; while Germany (the world’s fastest growing economy) received 5 per cent of its imports from India and sent 1½ per cent of its exports to India, making India the sixth largest exporter to Germany (after the USA, Russia, Britain, Austria-Hungary, France) and eighth largest importer from it (after Britain, Austria-Hungary, Russia, France, the USA, Belgium, Italy).

As of 1917-1918, India’s macroeconomics appear idyllic: an export surplus of £61.42 million, official reserves of £66.53 million, total claims on the rest of the world of £127.5 million (32.85 million troy ozs of gold), and a 1916-17 budget surplus of £6,594,885. The rupee, though legal tender only on the subcontinent, became what we might call a “super convertible” currency in being widely accepted in markets and stock markets from the Middle East through South East Asia to Australia.

Even at mid-century, India (without Pakistan) was still a trading power with 2 per cent of world exports and a rank of 16 in the world economy after the USA, Britain, West Germany, France, Canada, Belgium, Holland, Japan, Italy, Australia, Sweden, Venezuela, Brazil, Malaya and Switzerland. But then a collapse occurred over several decades to near insignificance in world trade and payments, from which India has yet to recover.

Of world merchandise exports, the subcontinent’s share fell to less than 1 per cent, and of Asia’s to less than 6 per cent, India accounting for two thirds; Malaysia alone accounted for more. Among 11 major developing countries (Korea, Taiwan, Singapore, Hong Kong, Argentina, Brazil, Chile, Mexico, Israel, Yugoslavia), India’s share of manufactured exports fell from 65 per cent in 1953 to 51 percent in 1960 to 31 per cent in 1966 to 10 per cent by 1973. And this was before the entry of China.

Even India’s legendary textiles lost ground steadily. As of 1962-71, India held an average annual market-share of almost 20 per cent of manufactured textile imports into the USA; this fell to 10 per cent by 1972-81 and less than 5 per cent by 1982-91. India’s share of Britain’s imports of textile manufactures fell from 16 per cent in the early 1960s to less than 4 per cent in the 1990s. India may not be among the top thirty merchandise exporters of the world today, although there has been new growth seen in areas like pharmaceuticals and computer-services.

Causes of the collapse include Western protectionism as well as emergence of new technologies and new competitors willing to use these. But it was largely policy-induced. Between 1939 and 1945/46, Britain clamped draconian exchange-controls on what remained of the Sterling Area (which, besides Eqypt and Iraq, included the Empire and Commonwealth without Canada, Newfoundland and Hong Kong). The controls were relative to currencies outside the Sterling area, principally the US dollar.

The new India and new Pakistan, far from ending these war-time controls of their respective rupees (as Britain would itself do gradually with the pound) instead made them more draconian to include the Sterling area as well. Hence the Ricardo-Keynes dictum was breached – the rupee remained an inexpensive medium for internal circulation but was no longer convertible externally, indeed it had become open to being debauched the more easily.

Milton Friedman in November 1955 argued to the government of India that the new sovereign country should remove exchange controls completely and have a freely convertible rupee at a floating market-determined price on the pattern of the Canadian dollar, along with a steady predictable monetary climate. Far from debating such a proposal, the government ignored his advice, and his document was suppressed until I published it 34 years later in May 1989 at the University of Hawaii.

Intricate barriers, subsidies and licensing (based on war-time “essentiality” and “actual user” criteria) continued, now in name of import-substitution and “planning”. Major industries were nationalised, which became leading consumers of imports obtained by administrative rationing of foreign exchange earned by export sectors. Domestic business predictably diverted to the large protected markets that resulted. Import restrictions of consumer goods and gold expectedly led to smuggling and open corruption in Customs.

A vast parallel or “black” economy arose with its thriving “hawala” sector. The exchange-rate was seen as yet another administered price, not a reflection of demand for foreign relative to domestic moneys. Foreign currency earnings from exports were confiscated in exchange for rupees at the administered rate, then rationed first to meet foreign debt repayments and government expenditures abroad like maintenance of embassies, military imports, official foreign travel, etc; then for import of food, fertilisers, petroleum and inputs required by government firms; then for import demands of those private firms successful in obtaining import licenses; lastly, to satisfy demands of the public at large for purposes like travel or study abroad.

Not only was extension of war-time exchange-controls seen as axiomatic, the massive war-time deficit finance via money creation that the British had indulged in with India’s public finances, came to be permanently institutionalised in the name of socialist planning.

On 7 December 1952 the planners said: “The raison d’ être of a planned economy is the fullest mobilisation of available resources and their allocation so as to secure optimum results. There is no doubt that the Reserve Bank, which is a nationalised institution, will play its appropriate part in furthering economic development along agreed lines”’; and on 14 May 1956: “Insofar as government expenditure is financed by central bank credit, there is a direct increase in currency in circulation”.

The fate of India’s paper money was sealed. Just as the Bank of England could “theoretically lend the full amount” the UK government was authorised to spend by Parliament, and the US government had assurance the Federal Reserve “could and would see that the Treasury was supplied with all the money that it needed for war finance beyond those secured by taxation and by borrowing from non-bank sources”, so government of India expenditure over seven decades has been for all practical purposes assured of automatic limitless financing via money creation. Since more than two dozen state governments have no money-creating powers, their debts also effectively accrue to the government of India.

The next mention of money supply was 43 years later on April 5 1999 in the “Ninth Plan” when it was said a “viable monetary posture” was “to accept an average inflation rate in the region of 7 per cent per annum, which would justify a growth rate of money supply (base money) of 16 per cent per annum”. Recent money supply growth has been near 19-21 per cent per annum, and inflation properly measured has been well above 10 per cent. Hidden in thousands of pages of the “Tenth Plan” dated 21 December, 2002, a half century after “planning” started, is found it being said it is “financed almost entirely by borrowing… India’s public finance inherits the consequence of fiscal mismanagement in the past”.

Had the rupee been a hard currency, the vast amounts of government debt that have accumulated today could have been evaluated at world prices. As things stand, the value at world prices of the asset-sides of banks becomes an unknown, making profitability uncertain of the domestic securities’ market in general. This compounds myriad problems of the mostly nationalised banking system, candidly surveyed over years by James A. Hanson and summarised in his sentence: “The Ministry of Finance continues to run the public sector banks”. AC Harberger a decade ago called for “thorough understanding of the facts” and a “serious study of India’s fiscal deficits”.

“Where are they being parked? At what cost? And how much vacant parking space remains to be occupied before major problems emerge?” “… the authorities appear to have little sense of alarm about these deficits. Does this represent a myopic and irresponsible vision, aimed at surviving the moment while passing an ever greater burden to future governments and later generations? Or does it mean the authorities have studied the problem well, and that today’s deficits are being placed in convenient parking lots that still have plenty of unused capacity?”

As no such study has taken place, the possibility of “a myopic and irresponsible vision” takes credence. Besides, foreign lines of credit have become squeezed or closed by separate crises in the USA, Europe and Japan. India is far from being a creditor country able to help out with any world problems at present.

The last 20 years have seen liberalisation in consumer goods imports and travel and study abroad, and the rupee is no longer an administrative price for current account purposes. Indian firms have been permitted to do business abroad, Indian residents to send large cash gifts to relatives abroad, as well as relative liberalisation of gold imports. A natural technological revolution has been underway inducing real growth in India as in the rest of Asia, where populations are large and families stable: even small increases in capital-per-head, combined with modern communication technologies making travel or migration unnecessary, may explain rapid growth in productivity and output.

To move towards a currency of integrity today that befits the real growth requires comprehensive candid study of the structure of government liabilities and expenditures, systematic cleaning of government accounts at their roots, seeking to raise productivity of government investments and expenditures by better use of the audit function, as well as bringing coherence to fiscal and monetary policy through institutional changes in the processes of public decision-making, specifically, separating the banking and central banking functions from the Treasury function, while bringing the planning function to be one serving the Treasury function rather than pretending to be above it.

Waste or ostentation in public expenditure itself creates incentives for evasion of taxes; indeed, the untaxed economy may even have caused an underestimation of real growth being made. The road exists to be taken though it may be one that demands excessive political courage.

The author thanks Dr Warren Coats for constructive comments on earlier versions of this article.

Endnotes

Friedman, Milton “A Memorandum to the Government of India 1955”, in Roy & James (1989).

A Memorandum to the Government of India 1955 by Milton Friedman

(published by me for the first time some 34 years later on 21 May 1989 at UH-Manoa…that original document was in my professorial office at IIT Kharagpur — and is yet to be returned despite a High Court order!

[EDITORIAL NOTE from *Foundations of India’s Political Economy: Towards an Agenda for the 1990s* edited by Subroto Roy & WE James…: “This memorandum is dated November 5, 1955, and was written at the invitation of the Government of India, where the author was working for some months as a consultant to the Ministry of Finance. It has not been published before. The editors believe it remains relevant to Indian discussions today. The history of the advice given by other Western economists in the early years of the Indian Republic has been recently surveyed by George Rosen in Western Economists and Eastern Societies: Agents of Social Change in South Asia 1950-1970 (Delhi: Oxford University Press, 1985).”]

“The Goal A 5% per annum rate of increase in real national income seems entirely feasible, on the basis both of the experience of other countries and of India’s own recent past. The great untapped resource of technical and scientific knowledge available to India for the taking is the economic equivalent of the untapped continent available to the United States 150 years ago. The basic question is one of method, of the social and economic arrangements that will best promote the conversion of these potentialities into realities while at the same time maintaining freedom and democracy and giving ever-widening opportunities to the mass of the Indian people. The belief that underlies these notes is that the basic requisites are a steady and moderately expansionary monetary framework, greatly widened opportunities for education and training, improved facilities for transportation and communication to promote the mobility not only of goods but even more important of people, and an environment that gives maximum scope to the initiative and energy of farmers, businessmen, and traders. The conquest of the technical frontier like the conquest of the geographical frontier requires a varied initiative by millions of individuals, flexibility of outlook and organization, and willingness to venture. The Government of India is doing much, and much that is highly effective, to bring these requisites into being. There is much more to do that at least in Indian conditions can be done only by the Government. But the Government also is following some policies and proposing others that are likely to hinder rather than promote economic development. The following comments, which are mainly restricted to such policies, deal with investment policy; policy toward the private sector; monetary policy; resources available to the public sector; and foreign exchange policy.

Investment Policy Over-Emphasis on the Capital-Output Ratio. There is a tendency not only in India but in most of the literature on economic development to regard the ratio of investment to national income as almost the only key to the rate of development, to take it for granted that there is a rigid and mechanical ratio between the amount of investment and additions to output. In the opinion of this writer, this seems a serious mistake. At the one extreme, output can increase even without investment; at the other, too high a ratio of investment may actually produce a lower rate of increase in income.

There are two reasons why the amount of investment and the increase in output can be, and empirically are, only loosely connected. First, the form and distribution of investment are at least as important as its sheer magnitude. Second, what is called capital investment is only part of the total expenditure on increasing the productivity of an economy. The first reason needs little additional comment. The second is perhaps less clear. In any economy, the major source of productive power is not machinery, equipment, buildings and other physical capital; it is the productive capacity of the human beings who compose the society. Yet what we call investment refers only to expenditures on physical capital; expenditures that improve the productive capacity of human beings are generally left entirely out of account. In the United States, for example, only about one fifth of the total income is return to physical capital, four fifth to human capital. By this writer’s estimate similarly, only about one fifth of the annual rate of growth in the United States can be attributed to the direct effects of investment in the usual sense; four fifth must be attributed to the growth in the productivity of human beings. Annual expenditures on improving the quality and quantity of human resources are at least as large as and perhaps much larger than investment as usually defined. Destroy the physical plant of the United States and leave the skills of the people and it would take but a few years to restore the initial position. Destroy the skills and leave the plant and the level of output would sink irretrievably. The cathedrals of medieval Europe, the pyramids of Egypt, the monuments of the Moghul empire in India are all testimony to the possibility of a high rate of investment in physical capital without a growth in the standard of living of the masses of the people. These considerations are especially important for India, precisely because its frontier is the frontier of technical knowledge and skill.

This is not to deny in any way the desirability of investment in physical capital. It is certainly highly important and is to some measure an indispensable concomitant of the development of human capital. But it is not the whole or even the most important part of the story. The danger is that concentration on it may lead to policies that increase physical investment at the expense of investment in human capital; and even within the area of physical investment, may lead to increases in the kind of physical investment that we can measure at the expense of kinds that we cannot measure. We must be aware lest we become the victims of our statistical creations.

Emphasis on Two Extremes Against the Middle. The form of investment is no less important than its kind. The chief problem in the Indian programme that impresses one here is the tendency to concentrate investment in heavy industry at the one extreme and handicrafts at the other, at the expense of small and moderate size industry. This policy threatens an inefficient use of capital at the one extreme by combining it with too little labour, and an inefficient use of labour at the other extreme by combining it with too little capital. The presumption for an economy like India’s is that the best use of capital is in general somewhere in between, that heavy industry can best develop and be built upon a widely diversified and much expanded light industry. We may hasten to add that this is only a general presumption which may well admit of special exceptions. Perhaps, for example, the steel industry is one exception in India.

Attempt to Do Too Much in the Public Sector. Indian thought may not have taken full account of the post-War experience of European countries in expanding the public sector. Country after country moved in this direction immediately after the War; to the best of the present writer’s knowledge, the results were in every case disappointing. This experience has produced a drastic change in the attitudes of the labour and left-wing parties toward nationalization and detailed state control over economic activity. The elements in the parties that have not changed their approach are now being dubbed “reactionary” by some of their fellows!

This point may be especially important for India. The areas for which only Government can take responsibility are here so large, so vital, and require such large investments that they alone would be a heavy burden on the limited administrative personnel of high calibre. It seems the better part of wisdom therefore to avoid any activities that can be left to others. The problem involves both the kind of activities taken into the public sector and the magnitude of investment. Some further comments are made on the latter below in discussing the resources available to the public sector.

Attempt to Control Private Investment in Too Rigid and Detailed a Fashion. (i) Cutting off particular investment projects may not make resources available for other uses but may simply eliminate savings that would otherwise have been available. Much saving is made to finance specific investment projects. If it cannot be used for that purpose, it may well be directed to consumption or to the accumulation of bullion or its equivalent. (ii) It is impossible to predict in advance the lines of investment that will turn out to be the most productive — as the failure of so many private enterprises amply demonstrates. There is therefore great need for a system that is flexible and can change easily. (iii) Detailed direction wastes scarce energies and ability of public servants in producing and enforcing regulations and of private individuals in trying to evade or avoid or change them. (iv) Given that the public sector gets the resources it demands, is not the market criterion appropriate for the allocation of the rest of investment? To frustrate it means to deny consumers freedom of choice and so to reduce the value to them of the goods produced. (v) Government does have a responsibility for seeing to it that the total of public and private investment is kept within the total resources of the community without inflation. But this can best be accomplished by monetary and fiscal policy, rather than by detailed regulation, leaving the allocation of investment among private industries to be accomplished by the interest rate. Insofar as this mechanism works imperfectly, measures to improve its operation seem preferable to supplanting it.

Policy Toward the Private Sector Protection of Inefficient Methods of Production. In addition to the Government controls already considered which are designed to direct investment, there are others whose purpose is mainly protective: the excise tax on factory-made shoes and factory-made textiles; reservation of markets, and the like. In the opinion of this writer, such policies seem misdirected. India’s basic problem is the inefficient use of manpower; it is no solution to protect inefficiency, and the attempt to do so leads to a waste not only of human resources but also of physical capital. The extra money consumers have to pay for the products, let alone direct subsidies to producers, could be channelled at least in part into investment. And there may even be actual disinvestment — we were told that some shoe machinery was lying idle and depreciating because of the tax.

There is a tendency to underrate the importance of nominally low taxes in promoting inefficiency. For example, there is a 10% tax on factory-made shoes. But half to two-thirds of the cost of shoes is the raw material. The tax therefore amounts to 20% or 30% of the value added by the factory, and it will not pay to produce shoes unless factory production is at least this much more efficient than hand production. The justification for these devices is to increase employment. The objective is fundamental, and would be worth achieving even at some cost in total output, but it seems to the present writer dubious that these means accomplish their objective even in the very short run, and certain that they work against it in the moderate or long run. What they do is to increase the number of people employed inefficiently; but they also decrease the number of workers in factories producing the same product, and in other industries stimulated by the higher income of the factory workers; the decrease is likely to exceed the increase but because it is more diffuse and less obvious, it tends to be neglected.

Coddling of Private Industry in Certain Directions Combined with Severely Restrictive Controls in Others. Just as it is inappropriate to discriminate in favour of the cottage industries, so it is equally inappropriate to discriminate in favour of factory industry or large concerns. Granting them special favours — in the form of especially advantageous loans, guaranteed markets, refusal of licenses to competitors, enforcing or even permitting private price-fixing and market-sharing agreements — simply encourages inefficiency and wastes scarce resources. If private industry is granted special favours by the Government, it is certainly inevitable that its use of these favours will be controlled; but this does not offset the harm done by the favours; it merely introduces new sources of rigidity and inefficiency. Business ingenuity is devoted to carving out protected sectors instead of to opening up new markets and lowering costs. There is no justification for private industry unless it is competitive, unless the right to receive profits is accompanied by acceptance of the risk of loss. Private industry should be made to stand on its own feet without either favour or harassment.

Monetary Policy Erratic Policy. A stable monetary climate is a basic prerequisite for healthy economic growth. Yet over the past five years, monetary policy has been highly erratic. It first permitted and facilitated substantial price rises, then reacted too far in the opposite direction. More recently, monetary policy has again reversed direction and again threatens to go too far, this time in an inflationary direction. This erratic policy is recorded directly in the behaviour of the stock of money and of wholesale and retail prices, and indirectly, in a less rapid rate of economic advance than would have been feasible.

The present writer believes that monetary policy in India would be more stable and consistent if the monetary authorities paid more attention to the size of the money stock and less to other indicators, and if they took as their proximate goal, a steady expansion in the money stock (allowing for seasonal influences) at a rate of something like 4 to 6 per cent per year. It may be noted that detailed examination of the record of American monetary authorities persuades one that this general proposition is equally true for the United States, with a desirable rate of expansion of the money stock of 4 per cent per year.

The importance of a stable monetary policy hardly can be overemphasized. There is probably no other single area in which mistakes can be more disastrous or appropriate policy more beneficial. The fact that it operates on a general level and makes its effects felt impersonally and indirectly is at one and the same time the reason for its crucial importance and for the widespread failure to recognize its importance.

Deficit Financing. Deficit financing is currently proceeding at the rate of something like Rs. 150 to 200 crores a year. Given the generally deflationary trend of the recent past, such a rate doubtless can be absorbed for a time without a serious price rise. It is exceedingly doubtful, however, that it can be for more than a year or so. According to some rough yet fairly detailed estimates made by this writer, something less than Rs. 500 crores is the maximum amount that can be absorbed over the next five years without a substantial rise in prices. By this estimate, continued deficit financing at a rate of Rs. 200 crores per year over that period would produce a price rise of at least 30 per cent, and perhaps much more.

Resources Available to the Public Sector There seems to be a general agreement that planned expenditures in the public sector substantially exceed expected receipts, even after allowing for a shortfall of actual expenditures, for deficit financing to the extent of Rs. 1,000 to 1,200 crores, and for a substantial amount of foreign aid. If we are right about the safe amount of deficit financing, the actual gap is substantially larger than the amounts generally cited. This financial gap corresponds to a real resource gap. It can be filled without curtailing the Plan only by either getting additional resources from abroad; or making domestic resources more productive over and above the 5 per cent per year increase already allowed for in the estimates; or transferring resources from other uses. The transfer of resources can be brought about by additional taxation, forced savings, additional voluntary savings, or a reduction in private investment. Additional voluntary savings and a reduction in private investment can in turn be brought about to some extent by a monetary policy that allows interest rates to rise. Inflation is of course a possible danger, but it is not really a separate method of filling the gap; it is a form of taxation and, in the view of this writer, a particularly inefficient and inequitable form.

This only states the problem. We have not been able to study in detail either the tax structure of India or the financial structure for mobilizing and encouraging savings, so no independent judgment can be given on the possibility of filling the resource gap by the various means. Casual impression suggests that there is some possibility of increasing tax revenues without doing much harm, but that any substantial expansion in tax revenues or heavy reliance on any of the other methods except for foreign aid is currently subject to extremely serious limitations. If this is so, filling the gap by their use, if successful, might make public investment larger only at the expense of reducing the rate of growth of aggregate real income by killing incentives outside the public sector, eliminating potentially productive private investment, and producing either inflation or a deadening network of direct controls. This is a special case of the point made earlier about the loose connection between the rate of investment and the rate of growth of income. It may well be that under the circumstances, cutting the size of the program may be preferable to trying to fill the gap on the revenue side.

On the tax side, three comments may be made: (i) The small scope of direct income taxes seems an obvious defect in the tax structure. A more broadly based tax with lower exemptions and more effective administration might both raise considerable revenues and produce a more equitable distribution of the tax burden. (One recognizes that for a country like India there are special problems of administration and enforcement that this writer is incompetent to assess.) (ii) The use of excise taxes for the protection of one method of production or one product as opposed to another not only promotes inefficiency but is also wasteful of revenue. A 10 per cent tax on shoes would yield more revenue, do less harm to productive efficiency and cost the consumer little if any more than a 10 per cent tax on factory-made shoes. As a side observation, is it clear that if the extra proceeds were used to facilitate the retraining and placement of hand workers it would be of less value even from the point of view of the employment problem? (iii) A minor possible source of additional revenue that would have favourable effects on efficiency is the auctioning off of licenses to use foreign exchange suggested as a possibility below.

The Foreign Exchange Problem The Foreign Exchange Gap. It is generally accepted that present programmes are likely to involve a substantial excess in the demand for foreign exchange over the available supply, even if allowance is made for foreign aid at roughly the present level. These estimates take for granted not only the investment program but also retention of the existing exchange rate and the existing structure of import and export controls. Even under these assumptions, the foreign exchange gap in part and perhaps in whole is a particular aspect of the total resource gap: any reduction in the total resource gap will automatically reduce the foreign exchange gap. Given the special foreign exchange resources that are likely to be available, we may guess that solution of the total resource gap would largely solve the foreign exchange gap as well.

Exchange Controls. The existing structure of exchange-controls and their associated system of import and export licenses and of discrimination between sources of purchases, seem to this writer a major obstacle to the growth and progress of the Indian economy. They involve waste and inefficiency in the use of foreign exchange. They introduce delay, uncertainty, and arbitrariness into domestic business activities. They impose on officials in charge of exchange control a task that is bound to be discharged most imperfectly, however able and devoted the officials may be. The criteria the officials use — and must use — tend to perpetuate the status-quo ante, and therefore constitute an obstacle to dynamic change and adaptation in an area that traditionally has been one of the most dynamic sectors in the economy and the source of much of the impetus to change. Exchange controls necessarily involve the indiscriminate distribution of implicit subsidies to those granted import licenses, and they lend themselves to abuse as a means of granting administrative protection from foreign competition to inefficient or monopolistic domestic producers.

The elimination of the exchange-controls and import and export restrictions is thus a most desirable objective of policy. It must be recognized, however, that it would probably increase the demand for foreign exchange, but the likelihood of an increase means that elimination of controls would have to be accompanied by the introduction of some other means of rationing exchange. It should be emphasized that this increase in the demand for foreign exchange is not a fresh problem that would be created by the elimination of exchange-controls. The problem is there now. That is why controls are deemed necessary. The question is whether there are not less harmful ways of solving it.

Alternatives to Exchange-Controls. One alternative, which retains central control over the amount of foreign exchange to be released, is to auction off whatever amount of foreign exchange it is decided to release, permitting the purchasers to use it for anything they wish and in any currency area they wish. This would be a far more efficient system of rationing and would hinder internal economic development far less than the present system and at the same time yield some revenue. We have not been able to construct even a rough estimate of the amount of revenue, but it is unlikely to be of major magnitude.

It would be preferable to avoid this auctioning system as well. While it eliminates any distortion in the pattern of imports, it does not produce the appropriate adjustment of exports to imports. Only two other basic alternative modes of adjustment to changes in the conditions of external trades are available: first, to inflate or deflate internally in response to a putative surplus or deficit in the balance of payments; second, to permit the exchange rate to fluctuate. At least in the present worldwide monetary conditions, the first is not desirable economically, since it puts internal conditions of trade at the mercy of changes in external conditions and these are about as likely to result from vagaries in the internal policies of other countries as from changes in the “real” conditions of trade. The preferable method is to let the exchange rate be determined in a free market — the method of a floating exchange rate that has been adopted by Canada with such conspicuous success.

It may be worth saying a few words about how a floating exchange rate eliminates any foreign exchange gap and means that there are not two problems, a total resource gap and a foreign exchange gap, but only one, a total resources gap. Suppose the total programme is in balance but, at the existing exchange rate, there is an excess of demand for foreign exchange over the supply. The result is to lower the rate. This makes India’s products more attractive to the outside world, foreign products more expensive to Indians. The result is to lead to an increase in exports, thus making more foreign exchange available, to shift the pattern of investment within India away from kinds with a large import component and toward kinds with a larger domestic resource component, away from production for the domestic market to production for the foreign market, and to shift consumption from foreign goods toward domestic goods. A putative foreign exchange surplus clearly has the opposite effects. In addition to these effects on trade, there are also, of course, effects on capital movements, which depend on whether the change in rate is regarded as temporary or permanent.

India’s membership in the Sterling Area raises obvious difficulties in the way of India’s acting alone, and may make it impossible for India to free her exchange rate except in concert with a similar move by Britain. However, if these difficulties could be surmounted, an independent movement by India might have very great advantages precisely because India is entering into a period of rapid economic change and is not a major financial centre. This writer believes there is more of an analogy between India’s and Canada’s positions than might at first appear. In a world of inconvertible currencies, a country that offers convertibility, albeit at a fluctuating fate, has a special attraction for investors and traders.

The problem of trade is frequently considered separately from that of the import of foreign capital. This is a mistake. Imports of goods may bring with them no capital directly but they bring businessmen and contact, and discovery of investment opportunities by people who are anxious to exploit them and who have contacts at home interested in such opportunities. Such continuous and intimate contact is likely to produce both a larger and, equally important, more productive flow of foreign investment than any number of missions coming out for brief periods with the objective of exploring investment opportunities.

Foreign Assistance. Any foreign assistance will of course help to fill both the total resources gap and the foreign exchange gap. Its direct impact, however, is much greater on the foreign exchange gap. In consequence, foreign assistance is especially likely to permit an elimination of import and export controls without threatening the existing exchange rate. But it would be a mistake to suppose that foreign assistance, however extensive, would permit elimination of controls, a fixed exchange rate, and an independent domestic monetary policy for any length of time. Even though the exchange rate is in some sense in long-run equilibrium, accidental fluctuations will from time to time produce large drains on reserves and if there is no mechanism for adjusting to them, these drains may well make the short-run position untenable.

Conclusion If these comments have concentrated largely on the financial machinery of economic organization, it is not because that is the only or even the most important problem facing India but rather because, on the one hand, it is more within this writer’s special competence, and on the other, it seems to be the area in which current policy can be improved most. The present writer is convinced that the fundamental problem for India is the improvement of the physical and technical quality of her people, the awakening of a sense of hope, the weakening of rigid social and economic arrangements, the introduction of flexibility of institutions and mobility of people, the opening up of the social and economic ladder to people of all kinds and classes. And what gives an outsider like this writer a feeling of optimism and hope about the future of India, makes one feel that India is on the move and will continue to move, is that so much is being done and such a good beginning has been made on this fundamental problem of creating the human and social basis for a dynamic and progressive economy.”

Subroto Roy hears Dr Manmohan Singh said yesterday (to journalists “on board Air India One” returning with him from Africa) “I think industrialisation is essential for the country to solve the problems of unemployment and poverty”. Nonsense Prime Minister! That is obsolescent or, at the very least, rather quaint Stalinist chatter. Try to provide public goods properly, which means getting the judiciary etc to work well. Try to get the public finances & public decision-making processes right, which means getting govt accounting & audit right and legislatures to work across the country. Try to drastically raise the productivity of public investments and expenditures. And try not to debauch India’s money any further than you have done. All that may make a good start. (And only when you have done all that do you really need to travel abroad again on “Air India One”; that thing the telephone really is a great invention…)

Subroto Roy is scolded by Ms Siddiqui: “Out of all the corrupt money grabbing racist ministers and governors and politicians you could find only Manmohan Singh to attack? Truly discerning arent you?”,

It is a quarter century precisely today since my monograph Pricing, Planning and Politics: A Study of Economic Distortions in India was first published in London by the Institute of Economic Affairs.

Now in May 1984, Indira Gandhi ruled in Delhi, and the ghost of Brezhnev was still fresh in Moscow. The era of Margaret Thatcher in Britain and Ronald Reagan in America was at its height. Pricing, Planning & Politics emerged from my 1976-1982 doctoral thesis at Cambridge though it came to be written in Blacksburg and Ithaca in 1982-1983. It was the first critique after BR Shenoy of India’s Sovietesque economics since Jawaharlal Nehru’s time.

The Times, London’s most eminent paper at the time, wrote its lead editorial comment about it on the day it was published, May 29 1984.

It used to take several days for the library at Virginia Tech in Blacksburg to receive its copy of The Times of London and other British newspapers. I had not been told of the date of publication and did not know of what had happened in London on May 29 until perhaps June 2 — when a friend, Vasant Dave of a children’s charity, who was on campus, phoned me and congratulated me for being featured in The Times which he had just read in the University Library. “You mean they’ve reviewed it?” I asked him, “No, it’s the lead editorial.” “What?” I exclaimed. There was worse. Vasant was very soft-spoken and said “Yes, it’s titled ‘India’s Bad Example'” — which I misheard on the phone as “India’s Mad Example” 😀

Drat! I thought (or words to that effect), they must have lambasted me, as I rushed down to the Library to take a look.

The Times had said

“When Mr. Dennis Healey in the Commons recently stated that Hongkong, with one per cent of the population of India has twice India’s trade, he was making an important point about Hongkong but an equally important point about India. If Hongkong with one per cent of its population and less than 0.03 per cert of India’s land area (without even water as a natural resource) can so outpace India, there must be something terribly wrong with the way Indian governments have managed their affairs, and there is. A paper by an Indian economist published today (Pricing, Planning and Politics: A Study of Economic Distortions in India by Subroto Roy, IEA £1.80) shows how Asia’s largest democracy is gradually being stifled by the imposition of economic policies whose woeful effect and rhetorical unreality find their echo all over the Third World. As with many of Britain’s former imperial possessions, the rot set in long before independence. But as with most of the other former dependencies, the instrument of economic regulation and bureaucratic control set up by the British has been used decisively and expansively to consolidate a statist regime which inhibits free enterprise, minimizes economic success and consolidates the power of government in all spheres of the economy. We hear little of this side of things when India rattles the borrowing bowl or denigrates her creditors for want of further munificence. How could Indian officials explain their poor performance relative to Hongkong? Dr Roy has the answers for them. He lists the causes as a large and heavily subsidized public sector, labyrinthine control over private enterprise, forcibly depressed agricultural prices, massive import substitution, government monopoly of foreign exchange transactions, artificially overvalued currency and the extensive politicization of the labour market, not to mention the corruption which is an inevitable side effect of an economy which depends on the arbitrament of bureaucrats. The first Indian government under Nehru took its cue from Nehru’s admiration of the Soviet economy, which led him to believe that the only policy for India was socialism in which there would be “no private property except in a restricted sense and the replacement of the private profit system by a higher ideal of cooperative service.” Consequently, the Indian government has now either a full monopoly or is one of a few oligipolists in banking, insurance, railways, airlines, cement, steel, chemicals, fertilizers, ship-building, breweries, telephones and wrist-watches. No businessman can expand his operation while there is any surplus capacity anywhere in that sector. He needs government approval to modernize, alter his price-structure, or change his labour shift. It is not surprising that a recent study of those developing countries which account for most manufactured exports from the Third World shows that India’s share fell from 65 percent in 1953 to 10 per cent in 1973; nor, with the numerous restrictions on inter-state movement of grains, that India has over the years suffered more from an inability to cope with famine than during the Raj when famine drill was centrally organized and skillfully executed without restriction. Nehru’s attraction for the Soviet model has been inherited by his daughter, Mrs. Gandhi. Her policies have clearly positioned India more towards the Soviet Union than the West. The consequences of this, as Dr Roy states, is that a bias can be seen in “the antipathy and pessimism towards market institutions found among the urban public, and sympathy and optimism to be found for collectivist or statist ones.” All that India has to show for it is the delivery of thousands of tanks in exchange for bartered goods, and the erection of steel mills and other heavy industry which help to perpetuate the unfortunate obsession with industrial performance at the expense of agricultural growth and the relief of rural poverty.”…..

I felt this may have been intended to be laudatory but it was also inaccurate and had to be corrected. I replied dated June 4 which The Times published in their edition of June 16 1984:

I was 29 when Pricing, Planning and Politics was published, I am 54 now. I do not agree with everything I said in it and find the tone a little puffed up as young men tend to be; it was also five years before my main “theoretical” work Philosophy of Economics would be published. My experience of life in the years since has also made me far less sanguine both about human nature and about America than I was then. But I am glad to find I am not embarrassed by what I said then, indeed I am pleased I said what I did in favour of classical liberalism and against statism and totalitarianism well before it became popular to do so after the Berlin Wall fell. (In India as elsewhere, former communist apparatchiks and fellow-travellers became pseudo-liberals overnight.)

The editorial itself may have been due to a conversation between Peter Bauer and William Rees-Mogg, so I later heard. The work sold 700 copies in its first month, a record for the publisher. The wife of one prominent Indian bureaucrat told me in Delhi in December 1988 it had affected her husband’s thinking drastically. A senior public finance economist told me he had been deputed at the Finance Ministry when the editorial appeared, and the Indian High Commission in London had urgently sent a copy of the editorial to the Ministry where it caused a stir. An IMF official told me years later that he saw the editorial on board a flight to India from the USA on the same day, and stopped in London to make a trip to the LSE’s bookshop to purchase a copy. Professor Jagdish Bhagwati of Columbia University had been a critic of aspects of Indian policy; he received a copy in draft just before it was published and was kind enough to write I had “done an excellent job of setting out the problems afflicting our economic policies, unfortunately government-made problems!”

Siddhartha Shankar Ray told me when we first met that he had been in London when the editorial appeared and had seen it there; it affected his decision to introduce me to Rajiv Gandhi as warmly as he came to do a half dozen years later.

Within a few months though, by the Fall of 1984, I was under attack by the “gang of inert game theorists” who had come to Blacksburg following the departure of James Buchanan. By mid 1985 I had moved to Provo, Utah, really rather wishing, as I recall, to have left my India-work behind me. But by late 1986, I was at the University of Hawaii, Manoa, where the perestroika-for-India and Pakistan projects that I and WE James led, had come to be sponsored by the University and the East West Center.

The unpublished results of the India-project reached Rajiv Gandhi by my hand on September 18 1990 as has been told elsewhere. A week later, on September 25 1990, Rajiv appointed a small group that included myself, to advise him. It was that encounter with Rajiv Gandhi that sparked the origins of the 1991 economic reform. Yet in 2007 one member of the group, declaring himself close to Sonia Gandhi, brazenly lied in public saying it was Manmohan Singh and not I who had been part of the group — a group of which I had been in fact the first member! Manmohan Singh himself has never claimed to have been present and in fact was not even in India at the time it was formed.

I have explained elsewhere here why I believe this specific lie came to be told by this specific liar who shared membership with me in the group that Rajiv had formed: because I had also pleaded with many and especially within this group that Rajiv had seemed, to my layman’s eyes, very vulnerable to assassination, and none of them had lifted a finger to do anything about it! Such is how duplicity, envy and greed for power make people mendacious and venal in politics!

As for Pricing, Planning and Politics, Dr Manmohan Singh received a personal copy from my father whom he had long known through the Kaul brothers, Brahma and Madan, both of whom were dear friends of my father since the War and Independence. From a letter Dr Singh wrote to my father, he would have received his copy in late 1986 when he was heading the Planning Commission in his penultimate appointment before retirement from the bureaucracy.

Readers of Pricing, Planning and Politics today, 25 years after it was published, may judge for themselves what if any part of it may be still relevant to the new government that Dr Singh is now prime minister of. The work was mostly one of applied microeconomics or the theory of value; in recent years I have written much also of applied macroeconomics or the theory of money as it relates to India. My great professor at Cambridge, Frank Hahn, was kind enough to say in 1985 that he thought my “critique of Development Economics was powerful not only on methodological but also on economic theory grounds”; that to me has been a special source of delight.

I should admit I think there is a Marxist theory for India/Pakistan/Bangladesh etc (perhaps including China) yet to be written except it will never get written by any Marxist as they tend to be innocent of all normal economics; it has to do really with Marx’s idea of a vast indeed unlimited ‘reserve army of labour’ in the rural areas which through migration keeps the general structure of wages low throughout the economy, and hence allows the technologically advanced “leading”/comprador sectors to be attractive to the outside world and hence generate scarce foreign exchange, which is then controlled quantitatively in its expenditure to pay for weapons’ imports, shopping malls, elite consumption etc. while a debauched local currency is made to preside over the abysmal and unreformed public finances…. It is a steady-state equilibrium that can continue indefinitely as the land is fertile enough and the climate agreeable enough for the rural poor to always have subsistence wages sufficient for consumption, growth and reproduction… Just a thought…

On second thoughts, it is a Marxist/Friedmanian theory that I have outlined, as at its core is not merely the reserve army of labour but the distortions caused by an externally controlled and internally debauched money.

April 26, 2010

“Public finances in India, state and Union, show appalling accounting and lack of transparency. Vast amounts of waste, fraud and malfeasance get hidden as a result. The Congress, BJP, official communists, socialists et al are all culpable for this situation having developed – over decades. So if you ask me, “Is the Indian state and polity in a healthy condition?” I would say no, it is pretty rotten. Well-informed, moneyed, mostly city-based special interest groups (especially including organised capital and organised labour) dominate government agendas at the cost of ill-informed, diffused masses of anonymous individual citizens ~ peasants, forest-dwellers, small businessmen, non-unionized workers, the destitute, etc. Demarcations of private, community and public property rights frequently remain fuzzy. Inflation causes non-paper assets to rise in value, encouraging land-grabs. And the fetish over purported growth-rates continues despite measurements being faulty, not reaching UN SNA standards, probably hiding increasing inequalities. India’s polity and economy are in poor shape for many millions of ordinary people. Armed rebellion, however, does not follow from this. Killing poor policemen and starting class-wars were failed Naxal tactics in the 1970s and remain so today. Naxals should put down their weapons and use Excel sheets and government accounting data instead.

Subroto Roy does not know if he just heard Manmohan Singh say “inflation will soon come down” — excuse me Dr Singh, but how was it you and all your acolytes uniformly said back in July 2010 that inflation would be down to 6% by Dec 2010? 6%?! 16% more likely! I said. Until he explains his previous error, we may suppose he will repeat it.

Subroto Roy says the central difference between the SubrotoRoy Model for Indiaas described in 1990-1991 to Rajiv Gandhi in his last months, and the Manmohan Singh Model for India that has developed since Rajiv’s assassination, is that by my model, India’s money and public finances would have acquired integrity enough for the Indian Rupee to have become a hard currency of the world economy by now, allowing all one billion Indians access to foreign exchange and precious metals freely, whereas by the model of Dr Singh and his countless supporters, India’s money and public finance remain subject to government misuse and abuse, and access to foreign exchange remains available principally to politicians, bureaucrats, big business and its influential lobbyists, the military, as well as perhaps ten or twenty million nomenclatura in the metropolitan cities.

April 8 2010:

Subroto Roy notes a different way of stating his cardinal difference with the economics of Dr Manmohan Singh’s Govt: in their economics, foreign exchange is “made available” by the GoI for “business and personal uses”. That is different from my economics of aiming for all one billion Indians to have a money that has some integrity, i.e., a rupee that becomes a hard currency of the world economy. (Ditto incidentally with the PRC.)

“After (Rajiv Gandhi’s) assassination, the comprador business press credited Narasimha Rao and Manmohan Singh with having originated the 1991 economic reform. In May 2002, however, the Congress Party itself passed a resolution proposed by Digvijay Singh explicitly stating Rajiv and not either of them was to be so credited… There is no evidence Dr Singh or his acolytes were committed to any economic liberalism prior to 1991 and scant evidence they have originated liberal economic ideas for India afterwards. Precisely because they represented the decrepit old intellectual order of statist ”Ma-Bap Sarkari” policy-making, they were not asked in the mid-1980s to be part of a “perestroika-for-India” project done at a foreign university ~ the results of which were received…by Rajiv Gandhi in hand at 10 Janpath on 18 September 1990 and specifically sparked the change in the direction of his economic thinking…”

Subroto Roy is interested to hear Mr Jaitley say in Parliament today the credibility of Government economists is at stake. Of course it is. There has been far too much greed and mendacity all around, besides sheer ignorance. (When I taught for a year or so at the Delhi School of Economics as a 22 year old Visiting Assistant Professor in 1977-78, I was told Mr Jaitley was in the law school and a student leader of note. I though was more interested in teaching the usefulness of Roy Radner’s “information structures” in a course on “advanced economic theory”.)

July 31 2010

Subroto Roy reads in today’s pink business newspaper the GoI’s debt level at Rs 38 trillion & three large states (WB, MH, UP) is at Rs 6 trillion, add another 18 for all other large states together, another 5 for all small states & 3 for errors and omissions, making my One Minute Estimate of India’s Public Debt Stock Rs 70 trillion (70 lakh crores). Interest payments at, say, 9%, keep the banking system afloat, extracting oxygen from the public finances like a cyanide capsule.

Subroto Roy is amused to read Dr Manmohan Singh’s Chief Acolyte say in today’s pink business newspaper how important accounting is in project-appraisal — does the sinner repent after almost single-handedly helping to ruin project-appraisal & government accounting & macroeconomic planning over decades? I rather doubt it. For myself, I am amused to see chastity now being suddenly preached from within you-know-where.

July 4 2010:

Subroto Roy does not think the Rs 90 billion (mostly in foreign exchange) spent by the Manmohan Singh Government on New Delhi’s “Indira Gandhi International Airport Terminal 3” is conducive to the welfare of the common man (“aam admi”) who travels, if at all, mostly within India and by rail.

Subroto Roy hears Dr Manmohan Singh say yesterday “Global economic recession did not have much impact on us as it had on other countries”. Of course it didn’t. I had said India was hardly affected but for a collapse of exports & some fall in foreign investment. Why did he & his acolytes then waste vast public resources claiming they were rescuing India using a purported Keynesian fiscal “stimulus” (aka corporate/lobbyist pork)?

May 26 2010:

Subroto Roy would like to know how & when Dr Manmohan Singh will assess he has finished the task/assignment he thinks has been assigned to him & finally retire from his post-retirement career: when his Chief Acolyte declares on TV that 10% real GDP growth has been reached? (Excuse me, but is that per capita? And about those inequalities….?)

Follow me on Twitter

Search Engine, “Fair Use”, Twitter

The search engine above should locate any article by its title; the Index and Archives may be used as well.
Readers are welcome to quote from my work under the normal “fair use” rule, but please try to quote me by name and indicate the place of original publication in case of work being republished here. I am at Twitter @subyroy, see my latest tweets above